FINANCING MICHIGAN RETIRED TEACHER

PENSION AND HEALTH CARE BENEFITS

September 2004

Report 337

A publication of the Citizens Research Council of Michigan

 Chairman
W. Frank Fountain

Vice Chairman President Treasurer

Kent J. Vana Earl M. Ryan Jeffrey K. Willemain

Board of Directors
Jeffrey D. Bergeron Randall W. Eberts Daniel T. Lis
Ernst & Young LLP W.E. Upjohn Institute Kelly Services, Inc.
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General Motors Corp. Standard Federal Bank Comerica Incorporated
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Collins Selections Hennessey Capital LLC Vanum, Riddering, Schmidt & Howlett LLP
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Pfizer Inc. National City Bank of Michigan/Illinois Henry Ford Health System
Terence M. Donelly Nick A. Khouri Jeffrey K. Willemain
Dickinson Wright PLLC DTE Energy Deloitte.

Advisory Directors
Louis Betanzos Will Scott

Board of Trustees
Chairman Vice Chairman
Daniel J. Kelly Patrick J. Ledwidge

Terence E. Adderley David Handleman James B. Nicholson

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Ferris State University Edw. C. Levy Co. Kent J. Vana
Gerald D. Fitzgerald Harry A. Lomason II Vanum, Riddering, Schmidt & Howlett LLP
Oakwood Healthcare Inc. Magna International Gail L. Warden
W. Frank Fountain Alphonse S. Lucarelli Henry Ford Health System
DaimlerChrysler Corporation Kenneth Matzick Richard E. Whitmer
Ralph J. Gerson William Beaumont Hospital Blue Cross & Blue Shield of Michigan
Guardian Industries Corporation Paul W. McCracken Jeffrey K. Willemain
Eric R. Gilbertson University of Michigan Deloitte.
Saginaw Valley State University M. Peter McPherson Larry D. Yost
Rodrick D. Gillum Michigan State University ArvinMeritor, Inc.
General Motors Corporation Mark A. Murray Betty J. Youngblood
Alfred R. Glancy III Grand Valley State University Lake Superior State University
Unico Investment Company

Citizens Research Council of Michigan is a tax deductible 501(c)(3) organization

 FINANCING MICHIGAN RETIRED TEACHER
PENSION AND HEALTH CARE BENEFITS

September 2004

Report 337

Citizens Research Council of Michigan

www.crcmich.org
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F INANCING M ICHIGAN R ETIRED T EACHER P ENSION AND H EALTH C ARE B ENEFITS

Contents
Page

In Brief ............................................................................................................................................................................ 1
Introduction .................................................................................................................................................................... 1
Primer on Retirement Benefit Funding .......................................................................................................................... 2
Health Care Benefits ........................................................................................................................................................ 3
Pension Benefit Funding ................................................................................................................................................. 4
Future Changes in Contributions ................................................................................................................................... 6
Health Care ........................................................................................................................................................ 7
Pension Benefits .................................................................................................................................................. 7
Projected Future Contribution Rates ................................................................................................................. 7
Combining the Pension and Health Benefit Rates ......................................................................................................... 7
Pension ................................................................................................................................................................ 7
Health ................................................................................................................................................................. 7
Policy Options ............................................................................................................................................................... 10
Pension Benefit ................................................................................................................................................. 10
Health Care Benefit .......................................................................................................................................... 10
Conclusion ..................................................................................................................................................................... 11

Tables
Table 1 – Michigan Public School Employees Retirement System: Unfunded Accrued Liabilities,
Health Benefits, FY1985 through FY2003 ..................................................................................................3
Table 2 – Investment Gains (Losses) Applied in Valuations, Fiscal Years Ending 1998-2003 ....................................4
Table 3 – Michigan Public School Employees Retirement System, Actual and Projected Contribution Rates,
Regular Pension and Health Benefits, Fiscal Years 1991 through 2015 ......................................................9

Charts
Chart 1 – Effects of the 2001 and 2002 Stock Markets, Investment Smoothing Calculation,
Fiscal Years Used in Each Valuation ..............................................................................................................5
Chart 2 – Level vs Pay-as-you-go Contribution Percentages ..........................................................................................6
Chart 3 – MPSERS Contribution Rates, Fiscal Years Ending 1991 through 2020 .....................................................8

Financial support and assistance in preparing this report was provided by the Michigan School Business Officials.

Citizens Research Council of Michigan i

 CRC REPORT

Citizens Research Council of Michigan

 FINANCING MICHIGAN RETIRED TEACHER
PENSION AND HEALTH CARE BENEFITS
In Brief
Funding pension and health care benefits provided by the
Michigan Public School Employees Retirement System
(MPSERS) will constitute an increasing burden on state fi-
nances in coming years. If the actuarial assumptions be-
yond FY2003 prove accurate, the contribution rate paid by
the employers will jump significantly from the 14.87 per-
cent charged by the State for FY2005 to over 20 percent in
FY2008. The sharp increase is the combined result of es-
calating health care costs paid on a pay-as-you-go basis; the
very large losses experienced in the stock market in 2001
and 2002; and the postponement of contribution rate in-
creases made possible by the use of reserves, soon to be
exhausted.
The effects of escalating pension costs on public school
Introduction
Prior to the implementation of Proposal A in 1995, the
State of Michigan and public school districts shared in the
financing of the employers’ shares of contributions to
Michigan Public School Employees Retirement System
(MPSERS) for public school districts.* Those contributions,
expressed as a percentage of active employee payrolls, pre-
funded the actuarial costs of the defined benefit plan pro-
vided to public school employees plus the costs of health
benefits for retirees on a pay-as-you-go basis. After Pro-
posal A was approved, full responsibility for financing the
employers’ contributions passed to the school districts.
Under the new finance system, the level of financial sup-
port was intended to provide sufficient resources for local
school districts to pay for MPSERS contributions.
Since 1995, the contribution rate has fluctuated. The over-
all contribution rate was actually lower in FY2004 than in
* MPSERS provides benefits to employees in 553 local school
districts, 57 intermediate school districts, 7 state universities, 28
public community colleges, 58 public school academies, and 10
public library organizations. These entities make contributions
supporting the benefits for their employees.
Citizens Research Council of Michigan
finance will be dramatic. In FY2005, the increase in
MPSERS contributions will average approximately $90 per
pupil, an amount greater than the entire per pupil increase
in school aid support. In the following three fiscal years,
the average per pupil increase in MPSERS contributions
will exceed $100 each year. In FY2008, the per pupil costs
of MPSERS contributions will average about $1,200.
In a year of moderate economic growth, the increase in
school aid revenues on a per pupil basis would likely aver-
age no more than $300. Combining increased costs for
MPSERS contributions and health benefits for working
employees leaves little room for increased spending else-
where in school budgets, even if the economy improves
throughout the period.
FY1995 because for FY2004 the system is using reserves
to keep the contribution rates below the actuarially calcu-
lated required levels. The use of reserves dedicated for
health care will hold the overall contribution requirement
for FY2005 to less than one percentage point of payroll
higher than it was in FY1995.
Three forces have emerged in recent years that portend
large increases in contribution rates in the next several years:
• Effective for 1997, system assets reflected the current
market value of investments in the calculation of fund
assets resulting in a large reduction in the contribution
rate. Prior to 1997, a five-year smoothed market value
method was used and that method has been employed
since 1997 as well. The savings in employer contribu-
tions at the school district level were reflected in the State’s
decision to provide no increase in the foundation allow-
ance portion of School Aid in the year of the change.
• The stock market declines in 2001 and 2002 created
huge losses in retirement fund investments during those
years and the losses, in turn, are causing increased con-
tribution rates. Loss effects are mitigated through the
use of a five-year averaging technique intended to lessen
1
 CRC R EPORT
A Primer on Retirement Benefit Funding
Most public employees are provided, as a part of their
compensation packages, benefits designed to enhance
their incomes following retirement. These benefits fall
into two categories: 1) post-retirement income, or pen-
sions, and 2) other post employment benefits, primarily
health care insurance.
Types of Pension Plans. Pension benefits are either 1)
defined by a formula usually based on employee compen-
sation and length of service (“defined benefit”), or 2) de-
termined by contributions to an employee account that
are invested to provide a pool of assets available to the
employee following retirement (“defined contribution”).
In defined benefit plans, the benefit formula is control-
ling and the responsibility for assuring payment of the
benefit falls on the employer. In defined contribution
plans, the benefit is determined by the amounts contrib-
uted and the earnings on those contributions with the risk
borne by the employee.
Financing Pension Benefits. In defined benefit plans,
the fiduciary responsibility of the employer is to assure
that assets are available to pay the benefits as they come
due. One way of doing this is through cash disburse-
ment funding (“pay-as-you-go”), in which the benefit is
paid to retirees out of current revenues of the govern-
mental unit. While this results in lower initial payments,
those payments rise and eventually may make payment of
the obligation unaffordable without increased taxes or
reductions in other expenditure items. Moreover, pay-as-
you-go financing shifts the burden of paying for the ben-
efit forward to future generations, thereby artificially re-
ducing the cost of providing services to those who re-
ceive them currently.
To avoid the problems associated with cash disbursement
funding, most defined benefit plans use advance fund-
ing, in which the employer makes contributions to a fund
based on the future pension liability created as employees
work and are paid. Actuarial determinations of the cost
of benefits arising from current service (“normal cost”)
are based on assumptions about factors that affect liabil-
ity, such as life expectancy; rates of salary change; rates
of departure from the work force before retirement; and
patterns of timing of retirement. The contribution rate,
2 Citizens Research Council of Michigan
which takes these factors plus the return on investments
into account, is computed as a level percent of payroll,
which will continue unchanged as long as the assumptions
made by the actuary are borne out by actual experience.
This makes the annual contribution predictable and facili-
tates accurate financial planning.
To the extent that actual experience varies from the actu-
arial assumptions, there may be gains or losses to the pen-
sion fund. Frequently, those variances are attributable to
ups and downs in the largely unpredictable markets in which
the pension funds are invested. In addition, the contribu-
tion rate may be affected by such things as early retirement
programs or changes in the pension benefit formula. To
the extent that the contribution to cover normal costs turns
out to be inadequate to cover the projected benefits, the
accrued actuarial liability will exceed the assets in the fund,
creating an unfunded accrued liability. In order to as-
sure that the funds are available to pay benefits when they
arise, actuarially determined contributions in addition to
those necessary to cover normal costs must be made over a
period of years, typically 30 or 40, to amortize the unfunded
accrued liability.
The existence of an unfunded accrued liability is not, by
itself, an indication of funding problems. The relationship
between assets and accrued liabilities, the funding ratio,
will vary over time and is generally not considered an indi-
cation of problems unless it is in long-term decline or is
very low. A pension plan with a funding ratio of 70 per-
cent, but growing, may be healthier than a fund with a ratio
of 80 percent, but falling.
Financing Other Postemployment Benefits (OPEB).
While advance funding is the norm for pension benefits, it
is not the norm for other postemployment benefits, which
are typically paid for on a cash disbursement basis. When
first adopted by governmental units, retiree health care ben-
efits amounted to only a few tenths of a percent of payroll
and putting them on a pay-as-you-go basis appeared to be a
manageable policy. These benefits now rival pension ben-
efits in their cost and their funding is becoming a major
fiscal problem. The arguments against cash disbursement
financing and in favor of advance funding apply equally to
pension and OPEB funding.
F INANCING M ICHIGAN R ETIRED T EACHER P ENSION AND H EALTH C ARE B ENEFITS

year-to-year fluctuations in contribution requirements.
The market decline will have an adverse effect on the
contribution rate for pension benefits through FY2008.
• The costs of health care for retirees have risen rapidly,
as is the case with group insurance rates for working
employees in all sectors of Michigan’s economy. Exac-
erbating the climb in health care costs is the rapid in-
crease in the number of retirees since 1995, 36 percent
in eight years compared with an increase of 11 percent
in the number of active employees. From FY1995
through FY2003, the actual contributions for health
care benefits for retirees increased at an annual rate of
12.7 percent.

Health Care Benefits

MPSERS provides health, dental, hearing and vision care
benefits to retired employees and their eligible dependents.
For employees retiring before age 65, health benefits are
provided by the system. Once a member of eligible depen-
dent becomes Medicare eligible, the system becomes sec-
ondary and coverage is coordinated with the Medicare pro-
gram. The benefits are in the form of insurance coverage
and the costs are financed by the employers on a pay-as-
you-go basis. The contribution rate, as a percentage of
active member payrolls, has been rising steadily to 6.05 per-

Table 1

Michigan Public School Employees Retirement System

Unfunded Accrued Liabilities
Health and Pension Benefits
FY1985 through FY2003
Health Pension
Unfunded Unfunded Pension Pension
Accrued Accrued Valuation Funded
Fiscal Liability Liability Assets Ratio
Year (millions) (millions) (millions) (Percent)
1985 $1,488 $1,928 $7,559 79.7
1986 1,651 612 9,645 94.0
1987 1,723 310 10,930 97.2
1988 1,982 2,206 11,823 84.3
1989 2,586 1,411 12,791 90.2
1990 2,984 2,020 13,746 87.2
1991 3,787 3,379 14,653 81.3
1992 4,415 4,230 15,333 78.4
1993 5,338 4,700 16,999 78.7
1994 6,014 6,511 18,503 74.0
1995 6,568 6,947 20,455 74.6
1996 6,682 6,042 22,529 78.9
1997 NA (259) 30,051 100.9
1998 NA 993 31,870 97.0
1999 11,040 253 34,095 99.3
2000 12,517 246 36,893 99.3
2001 13,802 1,375 38,399 96.5
2002 14,378 3,575 38,382 91.5
2003 15,706 6,043 38,726 86.5

NA – Not Available
Source: MPSERS Health Benefit and Pension Actuarial Valuations

Citizens Research Council of Michigan 3

 CRC R EPORT
cent in FY2004 and will increase to 6.55 percent in FY2005.
While pre-funding such benefits is not the norm, the cur-
rent financing practice virtually insures continuing increases
in the percentage into the foreseeable future.
Recently, the Governmental Accounting Standards Board
(GASB) issued Statement 43 containing standards to im-
prove post employment benefit plan reporting. The new
standards require disclosure of liabilities for such retiree
benefits as health insurance. (The State has reported the
unfunded liability for MPSERS health care for many years.)
Table 1 summarizes the steady rise in the unfunded liabil-
ity. In FY1985 the unfunded liability totaled $1.5 billion.
At FY2003 year end the unfunded liability had increased to
Pension Benefit Funding
The Michigan Constitution requires that pension benefits
be pre-funded and that any unfunded liability arising from
adverse actuarial experience or benefit changes such as early
retirement programs be amortized. Annual actuarial valua-
tions establish the percentage of payroll necessary to fund
the pension benefits. Most of the factors in the actuarial
calculations are relatively stable. They include mortality,
age patterns of retirement, and projected salary changes
for active members. The system is in the process of reduc-
ing the amortization period to 30 years from its present 33
years. This change will add to contribution requirements
in the next few years.
A factor that is subject to large annual fluctuations is the
return on investment. That factor is assumed at 8 percent
per year based on long-term trends in investment markets.
While this assumption has worked fairly well over the long
run, large fluctuations in the stock market can cause the
contribution percentage to fluctuate as well, even if the
long-term rate assumption is met.
In 1997, following several years of strong investment per-
formance, the State reset the valuation assets in the system
to current market value. This permitted capturing the strong
market performance in the form of reduced contributions
and an increase in the funding ratios of the system. Prior
to 1997, the valuation assets were computed using a five-
year smoothing calculation recognizing market values and
deviations from the assumed rate of return (8 percent). The
smoothing method was designed to reduce extreme year-
to-year fluctuations in the computed assets used to deter-
4 Citizens Research Council of Michigan
$15.7 billion and the percentage of payrolls necessary to
amortize that liability over 33 years and to pre-fund future
benefits was 15.4 percent of member payrolls. Table 1
also includes data tracking the funding status of the system’s
pension benefits and the financially strong position result-
ing from pre-funding the benefits.
Rising health care cost pressure is likely to continue. Expen-
ditures will also increase with the significant increases in the
number of retirees receiving the benefits. The growth rate
in the number retired will exceed the growth, if any, in the
number of active members. It is likely the contribution rate
for this component will rise each year and will overtake the
basic pension benefit percentage by early in the next decade.
mine the contribution percentage. The State resumed a
five-year smoothing calculation after the 1997 calculation
change. Table 2 summarizes the pattern of smoothed gains
and losses for the past six years.
Thus far, the change in the contribution percentage has
been tempered by smoothing. In the two-year period
FY2001 and FY2002 the market value of MPSERS’s port-
folio dropped about $10 billion as a result of a two-year
market rate of return of minus-22 percent. This is in con-
trast to the assumed increase of 8 percent per year from
Table 2
Investment Gains (Losses) Applied in Valuations*
Fiscal Years Ending 1998-2003
(Dollars in Millions)
Market Investment
Year Gains (Losses)
1998 ($ 5)
1999 497
2000 409
2001 (1,502)
2002 (1,384)
2003 296
* One-fifth of Gains (Losses) in Each Year
Source: MPSERS Actuarial Valuations
F INANCING M ICHIGAN R ETIRED T EACHER P ENSION AND H EALTH C ARE B ENEFITS

investments. The computed contribution rate for FY2004 FY2001, the computed contribution rate has climbed from
reflects both FY2001 and FY2002 in the five-year average. 6.48 percent of payroll to 9.74 percent. Chart 1 indicates
This is the second year that both years of significant losses that the effects of the market downturn will continue to
are reflected in the computed contribution rate. Since enter into the calculations through FY2008.

Chart 1

Effects of the 2001 and 2002 Stock Markets

Investment Smoothing Calculation
Fiscal Years Used in Each Valuation

Fiscal
Year
Contribution
Rate
Affected Year of Market Performance

2003 2001 2000 1999 1998 NA

2004 2002 2001 2000 1999 1998

2005 2003 2002 2001 2000 1999

1234567890
1234567890
2006 1234567890
2004 2003 2002 2001 2000
1234567890
1234567890
1234567890
1234567890
1234567890
2007 2005 1234567890
1234567890 2004 2003 2002 2001
1234567890
1234567890
12345678901
123456789012345678901
2008 1234567890
2006 1234567890
1234567890 2005 12345678901
2004 2003 2002
1234567890
1234567890
123456789011234567890
1234567890123456789011234567890
2009 1234567890
2007 1234567890
2006 12345678901
2005 1234567890
2004 2003

Losses

Gains
123456789012
123456789012
123456789012
Future Years
123456789012
NA – Not Applicable

Citizens Research Council of Michigan 5

 CRC R EPORT
Future Changes in Contributions
In order to assess future changes in contribution rates, it is
necessary to separate health care from the basic pension
benefits and make assumptions regarding each component
of the rate. The key assumptions are as follows:
• Health care will continue to be financed on a pay-as-
you-go basis. Savings resulting from changes in the
health benefit plan approved by the MPSERS Board
are expected to permit the FY2005 contribution rate
of 6.55 percent to continue in FY2006.
• Although in principle the changes in Medicare benefits
are likely to generate some savings for the system, no
estimates are available at this time. While savings re-
sulting from the changes will lower the contribution
rates, the path of the increases in the contribution rate
is not likely to be materially affected.
• After FY2006, total health care costs for existing and
new retirees will continue to increase at approximately
the annual rate of the last eight years (nearly 13 per-
cent) through FY2008. These cost increases will be
driven by increases in the number of retirees of about
3.5 percent per year and increases in the costs of insur-
ance premiums averaging about 9.5 percent per year.
After FY2008, it is assumed that the increases in pre-
mium costs will moderate to about a 7.5 percent rate.
• The investment portfolio will meet the actuarial assump-
tion of 8 percent market value return on investments.
• All other actuarial assumptions will be met. Impor-
tantly, increases in the number retiring each year will
add directly to health care costs.
Health Care
If health care were pre-funded from FY2005 forward and
the unfunded accrued liability amortized, the contribution
6 Citizens Research Council of Michigan
rate would need to be more than 15 percent of payroll.
The contribution rate on a pay-as-you-go basis has more
than doubled since 1991. The rise will continue from the
FY2005 and FY2006 percentages of 6.55 until the rate
reaches 20 percent or more at the end of the next decade.
Chart 2 compares funding percentages under level versus
pay-as-you-go calculations. The budgetary savings achieved
by postponing contributions into the future may place fu-
ture benefits at risk.
Pension Benefits
If investments are assumed to generate market value re-
turns of 8 percent each year, it will take several years be-
fore the portfolio returns to its pre market-downturn value,
adjusted for other factors such as contributions and benefit
payments. Even after a good market in 2003, the portfolio
value is less than it was in 1999. The effects of the two bad
market years will continue to adversely affect the contribu-
tion rate charged through FY2008.
Projected Future Contribution Rates
Projecting contribution rates into the future carries some
risk. Actuarial assumptions are just that: assumptions. Most
of the assumptions involve factors that change gradually,
such as life expectancy and the average age of employees
who retire. But factors such as the performance of invest-
ments and benefit changes introduce more volatility into
the calculations. Nonetheless, it is important to gauge the
future changes in this important financial requirement af-
fecting the budgets of all organizations whose employees
are members of the system. Since the State has used re-
serves in the stabilization sub-account of the pension fund
to postpone increases in the contributions, it is especially
important to forecast the timing of increases that are al-
ready calculated and known, in addition to projecting fu-
ture changes that will occur, assuming actuarial assump-
tions are achieved.
F INANCING M ICHIGAN R ETIRED T EACHER P ENSION AND H EALTH C ARE B ENEFITS

Chart 2
Retiree Health Care Benefits
Level vs. Pay-as-you-go Contribution Percentages

35

30

Pay-as-you-go Contribution
25 Percentage
Percent of Payroll

20

15
Level Contribution
Percentage
10

21
10

12

13

14

15

16

17

18

19
03

04

05

06

07

08

09

20

22

23

24

25
11
20

20

20

20

20

20

20

20

20

20

20
20

20

20

20

20

20

20

20

20

20

20

20
Fiscal Year

Combining the Pension and Health Benefit Rates

Pension
In FY2004, the health and pension charge to employers
has been 12.99 percent of payroll; 6.05 percent for health
and 6.94 for pension. The planned contribution rate for
FY2004-05 is 14.87; 6.55 percent for health and 8.32 per-
cent for pension. In both years the rate charged reflects
the use of reserves to hold the rate below the calculated
level. About $50 million of reserves will remain after
FY2005. Use of those reserves in FY2006 could permit
the contribution rate to be reduced for one year only by
about .5 percent of payroll.
If the remaining reserves are used in FY2006, in FY2007
the pension rate will rise to the unsubsidized level and fully
reflect the 2001 and 2002 investment performance by
FY2008. The unsubsidized rate for FY2005 will be about
10.1 percent of payroll, 1.7 percentage points above the
rate that will be charged that year. In addition, the rate will
climb in FY2006 through FY2008 as the stock market ef-
fects play themselves out.
It is important to note that favorable investment performance
relative to the assumed 8 percent market return would lessen
the increase in the contribution rate in the future and could
cause it to decline. While returns such as those achieved in
the later half of the 1990s are not likely, if the investments
out-performed the assumption by 2 percentage points per
year on average through the next eight years, the contribu-
tion rate could be as much as 2 percentage points lower.

Citizens Research Council of Michigan 7

 CRC R EPORT

Health of new retirees into the MPSERS will continue to drive

Health benefit contributions will continue to increase well
into the future under the current pay-as-you-go policy. If
the annual rate of increase in total payments since 1995
persists, annual increases in the contribution rate will ap-
proach 1 percentage point of payroll by FY2015. Extend-
ing that trend beyond that timeframe assumes that the ex-
plosion in health care costs will not evoke a response at the
national level to moderate the increases. But even with a
lessening of the increases in health care costs, the numbers
expenditures higher. Beyond FY2008, an annual increase
in total retiree health care expenditures is assumed to be 11
percent, adding roughly 0.7 percentage point each year to
the contribution rate initially and building up in the future.
Chart 3 and Table 3 combine the projections for both the
pension and health portions of the employer contribution
rate. In the short term, the rate can be expected to rise
from the 12.99 percent paid in FY2004 to more than 20
percent by FY2008.

Chart 3

MPSERS Contribution Rates

Fiscal Years Ending 1991 through 2020

35

30
Total
Contribution
25
Percent of Payroll

Health Benefit
20

15

10 Pension

ACTUAL CHARGES PRO JE CTED CHARGES

0
1991 1994 1997 2000 2003 2006 2009 2012 2015 2018
Fiscal Year Ending

8 Citizens Research Council of Michigan

F INANCING M ICHIGAN R ETIRED T EACHER P ENSION AND H EALTH C ARE B ENEFITS

Table 3

Michigan Public School Employees Retirement System

Actual and Projected Contribution Rates
Regular Pension and Health Benefits
Fiscal Years 1991 Through 2020

Fiscal
Year Regular Health Total
Ending Pension Benefit Percentage
A C T U A L

1991 8.06 2.73 10.79

1992 8.69 3.32 12.01
1993 9.06 2.11 11.17
1994 8.62 0.92 9.54
1995 10.91 3.33 14.24
1996 11.21 3.63 14.84
1997 10.97 3.95 14.92
1998 6.70 3.98 10.68
C H A R G E S

1999 6.73 4.04 10.77

2000 7.06 4.60 11.66
2001 6.61 5.55 12.16
2002 6.12 6.05 12.17
2003 6.94 6.05 12.99
2004 6.94* 6.05 12.99
2005 8.32* 6.55 14.87
PROJECTED CHARGES

2006 10.2 6.6 16.8

2007 11.6 7.3 18.9
2008 12.3 8.0 20.3
2009 12.5 8.7 21.2
2010 12.4 9.3 21.7
2011 12.3 10.1 22.4
2012 12.2 10.9 23.1
2013 12.1 11.7 23.9
2014 12.1 12.6 24.8
2015 12.1 13.6 25.8
2016 12.1 14.7 26.8
2017 12.1 15.9 28.0
2018 12.1 17.1 29.2
2019 12.1 18.4 30.6
2020 12.1 19.9 32.0

Sources: Actual Rates: Through FY 2005, Michigan Public School Employees Retirement System
Projected Rates: After FY2005, CRC Calculations
* Reflects subsidization from pension reserves. Unsubsidized rates would have been 8.37% in FY2004 and 10.1% in FY2005.

Citizens Research Council of Michigan 9

 CRC R EPORT
Policy Options
Pension Benefit
Michigan’s Constitution provides that the pension benefits
are a contractual obligation “which shall not be diminished
or impaired.” While the State has no options relative to
paying for the pension benefits for current working and
retired school employees, the system could be changed pro-
spectively to a defined contribution plan for new employ-
ees. The State made this change for state employees begin-
ning work on or after March 31, 1997 and offered employ-
ees working before the time of conversion the opportunity
to transfer their defined benefit assets to the new defined
contribution plan. Unlike a defined benefit plan where the
employer has the obligation to provide a benefit, which is
typically based on a formula related to the individual’s com-
pensation while working and the length of employment, a
defined contribution plan typically is based on employer
and often employee contributions that are usually calcu-
lated as a percentage of wages or salaries. Decisions on
investment of the contributions are usually the responsi-
bility of the employee and the investment assets are usually
portable with ownership moving with the individual when
job changes occur. The added flexibility for employees
making employment changes carries with it the added risk
of adverse investment performance, while the risk is borne
by the employer in a defined benefit plan.
If annual contributions to a defined contribution plan are
equivalent to those in a defined benefit plan, the assets avail-
able to pay benefits at the end of a typical 30-40 year teach-
ing career will be unlikely to support an equivalent retire-
ment income. The reasons for this are that: 1) a defined
benefit plan can count on a certain number of employees
leaving the system having earned little or no retirement in-
come, yet having had contributions made on their behalf,
while defined contribution assets are portable; and 2) in-
vestment decisions by employees tend to be more risk-
averse. As a result, returns over a long period tend to be
lower than those invested by a retirement system.
Other options that could be considered to reduce pension
costs include:
• Lower the benefit itself for future employees. Retirees
receive a benefit of 1.5 percent of their final average
compensation times the number of years of service. The
10 Citizens Research Council of Michigan
multiplier of 1.5 percent could be lowered for future
employees thereby lowering costs. It should be noted,
however, that a multiplier of 1.5 percent is relatively low
when compared to municipal retirement systems.
• Exclude purchased service in determination of early
retirement eligibility. Employees with 30 years of cred-
ited service may retire at age 55 with full pension and
health benefits. Members participating in the Member
Investment Plan (MIP) may retire at age 46 with 30
years of service. The 30 year service requirement may
be met in part by purchasing years of service based on
the actuarial cost of each year of purchased service.
The number of years of service determining eligibility
for early retirement could be increased to more than
30 years generating savings to the system.
• Raise employee contributions for pension. MIP par-
ticipants make contributions to the system in exchange
for enhanced benefits including cost of living adjust-
ments during retirement. Contributions could be re-
quired for new employees for a portion of basic pen-
sion benefits thereby reducing employer costs.
Health Care Benefit
Unlike the pension benefit, the health benefit apparently
does not carry with it the same degree of legal protection
provided in the Michigan Constitution. In February, 2004
the Michigan Court of Appeals found in Alberta Studier v
Michigan Public School Employees Retirement Board that increases
in prescription drug co-payments and deductibles were per-
missible. The Court specifically stated it could not rule
that health benefits constitute “accrued financial benefits”
under the Michigan Constitution “which shall not be di-
minished or impaired.”
There are many ways, in theory, to reduce the future costs
of health care coverage. One approach would be to shift
from employer contributions to premiums paid by retirees.
Employer costs could also be reduced by increasing co-
pays for the insured and narrowing the array of covered
benefits.
Another approach that has been considered in the past, but
not implemented, involves the determination of eligibility
for the health benefit. Currently, state law permits a public
F INANCING M ICHIGAN R ETIRED T EACHER P ENSION
school employee to work as few as five full years to qualify
for the full health benefit upon retirement. This is a very
generous plan, since a short-time employee or a part-time
employee can qualify for a benefit often worth more than
the basic pension. In 1997, the State changed the determi-
nation of retiree health coverage for state employees so it
is earned in increments of 3 percentage points per year of
service for a retiree vested in the system. The employee
must accumulate at least ten years of service to vest the
health benefit. The result is that an employee working the
full-time equivalent of ten years would receive a premium
subsidy of 30 percent and a 30-year employee a subsidy of
90 percent. Basing the benefit on years of service would
not only save money in the long run, but bring the health
benefit into concert with the basic pension which rewards
career service more than short-time employment. It is likely
that a change like this would need to be prospective for
new employees because of potential contractual consider-
ations regarding present employees.
Finally, there are other approaches that could be used to
address the future funding crisis in retiree health care:
• Begin pre-funding a portion of the benefit and allocate
any excess contributions to pre-funding. Larger cur-
rent contributions will lessen the contribution require-
ments in the future. If favorable experience occurs in
system financing, the overall contribution rate could
be maintained with any resulting savings dedicated to
health care pre-funding.
• Fund part or all of the future costs through pension
Conclusion
The outlook for MPSERS contributions and the effect on
school district budgets is decidedly gloomy. Employer con-
tributions for pension and retiree health benefits were
roughly 9 percent of local school district budgets in FY2003.
In that year, the contribution rate was 12.99 percent of
payroll. If the projections in this report materialize, the
contribution rate in FY2008 will be over 50 percent higher
(20 percent of payroll) than in FY2003 and FY2004. Even
if the economy grows enough to generate 4 percent in-
Citizens Research Council of Michigan
AND H EALTH C ARE B ENEFITS
obligation bonds that would permit investing bond pro-
ceeds in equities earning long-term rates exceeding in-
terest rates on the bonds. Over a period of years, the
system could sell bonds and invest the proceeds in eq-
uity investments earning greater returns than the bond
rates. This approach could make significant inroads in
the unfunded liability over a period of many years.
There are risks involved, however. Although equities
have out-performed bonds over the long run in the
past, there is no guarantee that they will out-perform
bonds in the future.
• Require active employees to make a contribution for a por-
tion of retiree health care. The contributions could be ear-
marked to finance the costs of benefits for future retirees.
• Require that the cost of any years of service purchased
by active employees include the future cost of health
care. Currently, when an employee retires early, addi-
tional health benefit costs are created. When purchased
service credit is used to reach the minimum years of
service, the purchased credit could be calculated to in-
clude the added health costs.
The financial difficulties caused by health care coverage in
MPSERS are symptomatic of the health care finance crisis
in the country. As the costs of health care claim larger and
larger shares of the economic activity in the country, pres-
sures for national health care are building in some quarters.
It is possible that a national response to this issue may oc-
cur before the MPSERS contribution rate for health care
becomes unaffordable.
creases in School Aid Fund revenues in FY2006 through
FY2008 (about $500 million per year), the increase in
MPSERS contributions will claim about 40 percent of the
increased revenues. This amounts to about $200 million
per year and about $125 per pupil each year. Combining
this projection with the likely continuing significant pres-
sure on health insurance premiums leaves little room for
growth elsewhere in school budgets.
11